Tragic quake may add to inflation pressures

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The full economic impact of the sixth most powerful earthquake ever recorded is not yet known. Many hundreds of lives have been reported lost in Japan. Aftershocks are a danger and other nations fear a tsunami running across the Pacific will spread the damage more widely. Though uncertainty is rife, the earthquake is more likely to add to global growth and attendant inflationary pressures than subtract from them. It also raises concerns about Japan’s long-running fiscal dangers.

The earthquake struck close to a relatively sparsely populated area of Japan. In contrast, the Kobe earthquake in January 1995 struck one of the most populated and industrialized regions, killing 6,434 people and causing damage estimated at around $100 billion. The current quake will leave a large reconstruction bill — but, on current indications, a smaller one than for Kobe.

Industrial and agricultural output in the area of the earthquake will be harmed. Some automobile and other industrial plants have had to close and may require repairs. Japan’s exports may be dented temporarily. Food prices in Japan may be pushed higher.

But spending over the coming months to remedy the destruction will tend to more than offset the economic losses suffered. There are already calls for a supplementary budget and there is no doubt that the government will be quick to repair infrastructure in the northeastern region — and will have to borrow more as a result. The Bank of Japan has promised to provide ample liquidity. Firms, meanwhile, will rebuild capacity, with insurance companies bearing much of that cost.

The earthquake will therefore mean an at least partial reversal of the austerity which the already embattled prime minister, Naoto Kan, has sought. The risks for Japan of fresh government spending when public debt is double the country’s GDP are plain, though bond yields are still very low and fiscal crisis is not imminent. But economic growth is more likely to be stimulated than to fall.

Markets have initially seen the opposite risk, that global growth and demand will be hurt by the earthquake. But if Japan, the world’s third largest economy, must spend to rebuild, Asian and global growth are likely to be a little stronger, too. That also means global commodity demand and inflationary pressure are more likely to be pushed up by the earthquake than to be reduced. Supply of some commodities may be harmed; the need for them increased.

The earthquake leaves the world shocked. Yet its economic impact may ultimately be to reinforce current trends: the global economy is recovering, but rising government spending and borrowing will one day have its toll.